Litigation: Lessons learned from the Dell saga in going-private transactions

Michael Dell recently succeeded in taking Dell Inc., the computer company he founded in 1984, private in a $25 billion dollar buyout. The transaction was consummated following months of drama involving Dell himself, veteran investor Carl Icahn (who tried to derail the deal) and a number of other institutional shareholders. But a starring role in the drama was played by the special committee of Dell’s board of directors, formed to evaluate Dell’s initial offer and all subsequent offers. The committee was critical to Dell’s defeat of Icahn’s legal challenge to the buyout. The role of that special committee, and the ways in which the committee was effective in protecting the transaction from legal attack, are worth further consideration.

The special committee has become a standard feature of going-private transactions because it meets several requirements imposed on corporate boards by corporate law, particularly as interpreted by the influential Delaware courts. Dell Inc., like many large corporations, is incorporated in Delaware, and the struggle to control the company was fought in part in Delaware courthouses. A fundamental principle of Delaware corporate law is that corporate directors owe fiduciary duties to their corporation, including the duties of care and loyalty. They discharge those duties by remaining informed about the corporation and its affairs and acting in a way that they in good faith believe to be in the corporation’s best interest. Provided that they fulfill their fiduciary duties, directors are protected by the business judgment rule. The business judgment rule shields them from liability for their decisions, even if those decisions turn out to be wrong, and further provides that courts will not second-guess those decisions.

The analytical framework shifts, however, in the context of a going private transaction led by a dominant, related party shareholder (such as Michael Dell in the Dell, Inc. transaction). Michael Dell and his investors, led by private equity firm Silver Lake, proposed to acquire 75 percent of the company. Dell owned 16 percent at the outset and sat on the board of directors. In a going-private transaction led by a controlling shareholder, presumptions of the business judgment rule will frequently not apply to protect against a shareholder challenge, shifting the burden to the directors to show that the proposed transaction is “entirely fair” to the corporation and its shareholders. The entire fairness standard, as enunciated by the Delaware courts, is sufficiently demanding to be characterized as outcome-determinative by many observers. That is, if the burden shifts to the directors to show the entire fairness of the going-private transaction, they may abandon the transaction altogether.

Enter the special committee. If a court finds that a properly constituted special committee, supported by adequate resources, sufficiently investigated the merits of the going private transaction, canvassed for alternatives, and engaged in vigorous arms-length negotiations with the shareholder seeking to take the corporation private, the court will likely conclude that the demanding standard of entire fairness is satisfied. Furthermore, if the special committee conditions approval of the transaction on a vote of the majority of the remaining disinterested shareholders, the committee can shift the burden back to the challenging shareholder to demonstrate a lack of entire fairness. To ensure that the special committee will have the desired legal effect, the committee should be composed entirely of disinterested and independent directors who are authorized to evaluate and negotiate the going-private transaction on behalf of the minority shareholders. The special committee should retain independent financial and legal advisors to assist in evaluating the proposal and negotiating with the controlling shareholder.

In the Dell, Inc. transaction, the special committee acted with vigor, contacting 67 potential bidders during a 45-day “go shop” period following Dell’s announcement of his offer in February 2013. Icahn informed the board in March that he had acquired a substantial block of shares and would fight the transaction. Blackstone made a competing bid for the company. And several other large shareholders, including Southeastern Asset Management, Harris Associates, and Yacktman Asset Management, also expressed opposition to the going-private transaction.

During the course of the special committee’s evaluation of the transaction, Michael Dell’s group benefited from continuing weakness in Dell, Inc.’s PC business, which discouraged competing offers. Blackstone abandoned its bid in April, citing a 14 percent drop in PC volume. Moreover, the special committee was able to determine that Michael Dell’s was the only credible offer for the entire company. Icahn initially proposed buying only 58 percent of the company while increasing its debt load, a proposal the special committee regarded as fraught with risk. The special committee ultimately concluded that Icahn was nearly $4 billion short of the cash needed to finance his proposed $12 per share special dividend, and recommended the Dell/Silver Lake buyout.

Ultimately, the fate of the company was decided in Delaware’s Court of Chancery. Icahn sued in August, seeking an expedited hearing and an order seeking to block Dell’s planned shareholder vote approving the buyout. But in a conference on Aug. 16, Chancellor Leo Strine, Jr., rejected Icahn’s demands. He found that Icahn had not mounted any credible challenge to the independence of the Dell special committee and had not shown any violation of the directors’ fiduciary duties. Strine therefore denied the request for an expedited hearing and refused to interfere with the committee’s scheduling of the shareholder vote. Icahn threw in the towel shortly afterwards, and Michael Dell’s final offer ($13.75 a share plus a 13 cent per share special dividend) was accepted by the shareholders.

It remains to see if Michael Dell’s plan to transform Dell, Inc. from a PC maker to an enterprise software company can succeed. But his going-private transaction, supported by an independent, energetic special committee, already has and serves as an example of how corporations and their boards of directors can navigate the murky waters of related party transactions.